Johannesburg, 09 Feb 2005
Having seen some aggressive and surprising interest rate cuts both in 2003 and last year, as we commence 2005 there is much talk as to whether we will see any further interest rate cuts this year, or indeed whether we will see the opposite - interest rate hikes.
In most modern economies, inflation concerns are predominantly cited as the reason for interest rates not being lowered or indeed being raised. However, with strong GDP growth and excessive credit growth often being preludes to future inflation, any significant shift in these measurements would normally put pressure on the monetary authorities to raise rates in order to head off any inflationary dangers.
In SA we are witnessing healthy GDP growth, in the region of 4.5% which is certainly above trend, and more significantly credit growth data is showing private sector credit growth at record levels. With these indicators being so high relative to previous levels, we would normally expect some shift in monetary policy and we should certainly not expect any further rate cuts. However, is this appropriate for the South African economy? Should we be looking at this economy in the "normal" developed market economic framework relying on the traditional indicators to guide us?
I argue that the dramatic rebirth that the South African economy continues to enjoy, distinguishes it significantly from "normal" developed economies and hence we cannot (and should not) look at traditional data in isolation when forming monetary policy. A softer and more "wait and see" approach is appropriate in order to determine the correct level of interest rates.
Firstly, the South African economy has come an extraordinarily long way in the last three years. However, the groundwork for these years of success began a long time ago back in the mid-1990s and is still continuing today. Prudent fiscal policy laid the foundations for economic stability, and this stability was built upon by a very capable Reserve Bank. Nonetheless, the fundamental "structural" changes that are taking place within the economic framework of SA are still very much unfolding. What I regard as phase two of the current finance minister`s agenda (phase one being the setting up of a very prudent current account framework and policy), is that of capital investment which is commencing with specific investment projects that are unveiled on a monthly basis. The effect of this massive shift in spending and investment is not currently captured in traditional measures, and hence the true effect of this is difficult to estimate at this stage.
Secondly, many of the contributory factors to inflationary pressures in developed economies, such as a lack of labour, supply bottlenecks and lack of resources, do not apply to the South African economy. And while government spending is increasing, "crowding out" (a phenomenon whereby government spending is so significant that it squeezes out the traditionally more efficient private sector and pushes prices higher) is not yet an issue in SA, again unlike many developed economies. Managed correctly, there is room in the economy to readily absorb more expansion than currently assumed.
Thirdly, while SA does currently consume more imported goods than it exports, this is more than offset by increasing capital inflows with foreigners continuing to buy South African assets and domestic investors bringing money home. The relative flow of funds between the money coming into SA and the money leaving through imports is readily observable in the exchange rate. And just look at the strength of the rand over the course of the last three years. There is little danger, as a result of economic conditions, of the currency devaluing significantly and bringing with it inflationary pressures in the short- to medium-term.
While the issues highlighted above are very much in hand and under control at the moment, there is always the danger that things can go very wrong, very quickly. Any poor wage negotiation processes which are seen to be overly conciliatory or indeed any issues surrounding property rights could result in an immediate about-turn in the current exceptionally strong domestic and international investment appetite.
As highlighted above, a variety of significant economic and social factors are currently in hand, are favourable and indeed are improving. As a result of this, I would strongly advocate that any decision on monetary policy should not be drawn uniquely from a set of economic data, and that softer issues are allowed to unfold in the interim. Indeed, just look at the inflationary statistics out recently; inflation came in below even the lowest forecaster`s prediction; and that even in light of hard statistics which would normally serve as indicators of inflationary pressures building up.
The South African economy is unlike any other economy in the world, as many of us can testify to, with very strong positive and negative "economic" memories. Let`s not treat it simply the same as other developed economies.
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